Frank Talk Blog

Share this page with your friends:

A Test of Strength for Gold

February 25, 2013

When investing in gold, I often say diverse opinions promote critical thinking and a healthy market. I believe elevated groups of buyers and sellers create a competitive tug-of-war in the bid and ask price of the precious metal.

Last week, we saw the gold bears growling louder and gaining strength, as the world’s largest gold-backed ETF, the SPDR Gold Trust, experienced its largest one-day outflows since August 2011. The Fear Trade fled the sector following the Federal Reserve’s meeting that revealed a growing dissension among some of its members over the central bank’s bond-buying program.

Despite the discord, the Fed is continuing its course to purchase $85 billion of bonds every month and keep interest rates near zero. Ben Bernanke’s plan bloating the balance sheet to more than $3 trillion has been keeping the Fear Trade coming back for more metal.

For good reason, too, as the correlation between the Fed’s balance sheet and the price of gold has historically been very high, at 0.93, according to Macquarie Research. The firm found that for every $300 billion expansion in the balance sheet of the U.S. government, there was a $100 an ounce increase in the price of gold. When you factor in the Fed’s current bond purchases totaling $85 billion per month for the next nine months, the central bank will be adding $765 billion in new assets. “Using the previous ratio, this would compute to a $255 an ounce increase in the gold price,” says Macquarie. By this measure alone, gold would rise approximately 16 percent over the next several months.

On Bloomberg’s Taking Stock with Pimm Fox last Friday, I said that Bernanke will likely keep liquidity high for quite some time, in his effort to meet his goal of lowering the unemployment rate. If the Fed did take its foot off the bond-buying pedal sooner than planned, such a move is apt to shake the resolve of some gold buyers. It’s easy to be confident in gold in times of extreme fear; when the economy improves, one may no longer feel that gold stands on solid ground.

Take another period characterized by extreme volatility and fear, when there was conflict in the Middle East, oil-related inflation shocks, declining value in the U.S. dollar, rising U.S. unemployment and a strong resolve from the Fed to act aggressively. This was four decades ago, after President Richard Nixon removed the gold standard, and the yellow metal climbed to a peak of $850 by January 1980.

Back then, India and China had little financial footing in global markets; gold demand from these areas of the world was about 15 percent of total demand.

Since then, we’ve seen a rapid increase in GDP and incomes, resulting in a dramatic rise in gold demand. According to the World Gold Council (WGC), there’s now an “increasing relevance of emerging markets in the gold market, particularly over the past 12 years.” In 2011, you can see that emerging markets accounted for 74 percent of total bar and coin, jewelry and ETFs gold demand. India and China alone make up 50 percent, and together with Turkey, Vietnam, and Southeast Asia, these countries’ residents clearly “have a cultural affinity to gold,” says the WGC.

To help investors analyze whether gold continues to be a wise investment, I like to refer to the book The Wisdom of Crowds by James Surowiecki. There are four factors to consider whether a crowd is suffering from groupthink or is making wise decisions:

Ultimately, the key to gold is moderation. As I said in my book, The Goldwatcher, and often reiterate to investors when I speak at conferences, gold is a volatile asset class and the daily price can be more dramatic than blue-chip stocks. We have always advocated that investors hold a modest 5 to 10 percent weighting in gold and gold stocks. In other words, we feel strongly that an investor should not try to get rich from the metal.

Marc Faber expressed a similar idea in this month’s Gloom Boom and Doom Market Commentary. Instead of selling his gold when the price is falling and buying it back at a lower price, he says he doesn’t stray from his asset allocation approach. He holds a 25 percent allocation to gold, which is much higher than we recommend, and believes that if the price of gold declined, it is likely that his financial assets would increase.

In his closing, Faber reminds readers of the English Proverb: “When we have gold, we are in fear; When we have none, we are in danger.” If the proverb were written today, it might be revised to say, “When we have gold, we are in love.”

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The following security mentioned was held by one or more of U.S. Global Investors Funds as of 12/31/12: SPDR Gold Trust ETF.

Please consider carefully a fund's investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by clicking here or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

With respect to the Fidelity Institutional Money Market Treasury Portfolio, which is distributed by Fidelity Distributors Corporation, an investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

Read additional important information.

Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes. The tax free funds may be exposed to risks related to a concentration of investments in a particular state or geographic area. These investments present risks resulting from changes in economic conditions of the region or issuer.

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

The Emerging Europe Fund invests more than 25% of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile.

Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries.

Stock markets can be volatile and share prices can fluctuate in response to sector-related and other risks as described in the fund prospectus.

Morningstar Ratings are based on risk-adjusted return. The Overall Morningstar Rating for a fund is derived from a weighted-average of the performance figures associated with its three-, five- and ten-year (if applicable) Morningstar Rating metrics. Past performance does not guarantee future results. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating? based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.)

Each of the mutual funds or services referred to in the U.S. Global Investors, Inc. website may be offered only to persons in the United States. This website should not be considered a solicitation or offering of any investment product or service to investors residing outside the United States.

Certain materials on the site may contain dated information. The information provided was current at the time of publication. For current information regarding any of the funds mentioned in such materials, please visit the fund performance page.

Some link(s) above may be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.